Monday, November 21, 2005

Capital Formation

One thing that's become clear -- whether it's in donating money to poor countries or poor people -- is that straight transfers of wealth do not alleviate poverty. Poor people, and poor countries, lack the capital or institutions neccessary to generate and build their own wealth. This may not be there fault, but that does not change what needs to happen to make them wealthier.

The standard economic position on wealth transfers is that it ought to be done in cash -- after all, an individual can spend the cash on whatever they like, and since they know what they like better than anyone else, you get the most utility by simply giving them money and then letting them spend it as they choose.

In practise, this has been a political non-starter, individuals support giving money to the poor but also have very clear ideas on what the poor (country or person) then can legitimately spend the money on. Milk -- OK, 40s -- not so much.

If the problem is a fundamental lack of capital, or the institutions that enable capital formation, then this political instinct is right and the economic position wrong.

We still have numerous special programs for food, medical care, housing, child care, and the like. Indeed, the pure general-purpose cash programs have become very small relative to everything else. From an economist's standpoint, this is problematic. We generally believe that the most efficient way to help people is to give them a direct cash transfer, because they know better than us what their needs are and how they should allocate their resources. But the public, I think, believes that the poor have demonstrated that they do not make good choices on their own, and that we should give them the services we believe they need rather than allowing them to purchase them on their own. The voters, I believe, are basically paternalistic toward the poor and this has shaped the policies we have adopted.

In general I do not agree with paternalism, but if you accept that poverty reveals an inability to make sound choices, then alleviating poverty must include teaching people how to make better choices.

I would recommend reading the entire article -- it's very good. (Thanks to marginal revolution for the pointer).